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May 22, 2014, by RASHAD COLLINS, on Franchising |

By now, most everyone has heard about the racial bigotry expressed by Donald Sterling, owner of the National Basketball Association’s Los Angeles Clippers franchise.  The nation anxiously awaited NBA commissioner Adam Silver’s response to Sterling’s reprehensible behavior, especially as to whether the league and its owners would completely terminate Sterling’s ownership and involvement with the NBA.  There were conflicting reports in the media as to whether the Commissioner and the other twenty-nine owners even had the authority to do so, as the NBA’s governing documents are not public record.  As it turns out, a mechanism does exist pursuant to the league’s constitution and by-laws that provides for the detachment of an owner from his franchise under certain circumstances.  But what if there were no legal path to termination of Sterling’s ownership? The building backlash, coupled with the widely reported playoff game boycotts that the players were organizing, undoubtedly would have dealt a crippling blow to the NBA brand both domestically and internationally. 

In today’s world of the 24-hour news cycle, TMZ, and rapidly expanding social media, the NBA’s “Sterling problem” is yet another powerful example of why franchisors should include a broad moral turpitude clause within franchise agreements.  Yes, most franchise agreements contain some form of a moral turpitude clause; however, most of these clauses cover crimes involving moral turpitude and not simply public acts of moral turpitude.  For example, franchise agreements often provide franchisors with “the right to terminate the franchise agreement upon notice if the franchisee, or its owner or director, is convicted of or pleads nolo contendere to a crime or felony involving moral turpitude.” Similarly, the Petroleum Marketing Practices Act (PMPA) arms franchisors with the right to terminate covered franchisees who are convicted of “any felony involving moral turpitude.”  These provisions have long been enforced by the courts.  

In Alexander v. Exxon Co., U.S.A., 949 F.Supp. 1248 (M.D.N.C. 1996), a federal court in North Carolina held that a franchisee's guilty plea to a felony charge of conspiracy to distribute cocaine was sufficient grounds for Exxon’s termination and nonrenewal of the franchise relationship under the PMPA, solely because the franchisee was convicted of a “felony involving moral turpitude”.  In Camina Services, Inc. v. Shell Oil Co., 816 F. Supp. 1533 (S.D. Fla. 1992), the court found that the conviction of the franchisee’s president, director, and 50% owner for possession of cocaine with intent to distribute (a felony involving moral turpitude) permitted termination and nonrenewal of his franchise under the PMPA and also the dealer agreement, motor fuel station lease, and auto care agreements entered into by the parties.

Nonetheless, as plainly demonstrated by the Donald Sterling disaster, franchisors should strongly consider broader termination language concerning acts of moral turpitude that are not wedded to the commission of a criminal act.  There are different ways to accomplish this goal.  The agreement could provide the franchisor with the right to terminate upon notice if the franchisee engages in conduct constituting moral turpitude which materially impairs the brand, marks and/or goodwill associated with the franchise.  Said language may provide a franchisor a leg to stand on when dealing with the public statements and actions of a Donald Sterling type franchisee; whereas, a moral turpitude clause that is dependent upon criminal activity is worthless in the same situation, even though the damage to the brand may be just as devastating as if it were committed in conjunction with a crime.

One could argue that precedent already exists for the inclusion within a franchise agreement of a moral turpitude clause that is detached from purported franchisee criminal activity.  Franchise agreements that allow franchisees to assign or sell their interests in the franchise typically provide franchisors with the right to withhold acceptance of a proposed transferee.  Said right is usually based upon the absence of standard business experience or lack of good moral character on behalf of the proposed transferee.  These clauses, essentially, allow franchisors to unilaterally preclude the sale of one of its franchises to or the purchase of one of its franchises by a party whom the franchisor deems to lack good moral character.  As such, is there a real difference between the same and a franchisor’s termination of a current franchisee for acts of moral turpitude that materially damaged the brand?  At the baseline of either scenario, the law is simply allowing the franchisor to make a business decision regarding the pros and cons of associating (or continuing to associate) a particular franchisee with its brand, based upon the moral character publicly displayed by the franchisee.  

We can dispense with the counterpoint of unjust enrichment, in the case of termination of a current franchisee, by agreeing that franchisors could not terminate a franchisee for cause due to moral turpitude and then summarily confiscate all of the franchisees’ business assets – the land, building, equipment, etc. purchased by the franchisee – because franchisors cannot do that under any other termination for cause scenario.  Nevertheless, franchisors should be able to terminate franchisees pursuant to a moral turpitude clause where the franchisee’s actions have had a materially adverse effect on the brand.   The franchisor should have the option to either force the sale of the franchise or repurchase the franchise for fair market value.  The then current fair market value of the franchise should itself reflect the scorched earth left behind by the franchisee’s public acts of moral turpitude. 

It goes without saying that if a franchisee files suit for improper termination, the franchisor would have to demonstrate materiality.  Proving materiality is not impossible, as American litigants argue the concept on a daily basis.  Whether implementing a 5% threshold as seen throughout securities law jurisprudence or some other threshold to be determined, courts are sophisticated enough to decipher the proper level of damage to a brand which justifies a franchisor’s business decision to terminate a franchisee pursuant to the moral turpitude language suggested above.  Additionally, it is important to note that the decline in fair market value of the offending franchisee’s business should not be the determinative factor for whether his public acts of moral turpitude have had a material, negative effect on the overall brand. 

Harkening back to the Donald Sterling debacle, the fair market value of the L.A. Clippers franchise would not decline due to Sterling’s behavior, because a plethora of billionaires want to own an NBA franchise; conversely, the NBA’s total revenues from ticket sales, merchandising, and corporate sponsorships would certainly have taken a hit in the aftermath of the scandal had Commissioner Silver not announced the punishments of a lifetime ban and the impending forced sale of the franchise.  All-in-all, if courts will consider the totality of the circumstances when determining materiality, franchisors should include a broad, non-criminal moral turpitude clause within franchise agreements that allows for termination when franchisees commit such acts that materially damage the brand.

What’s good for the goose is good for the gander

Naturally, the story doesn’t end here.  Franchisees should not fret the inevitable expansion of the moral turpitude clause because it may provide them a pathway to certain protections of which they currently have no access.  Franchisees cannot punish or sue a franchisor for damaging the brand due to poor business judgment, acts of moral turpitude, or anything else.  Concerning the first point, I previously wrote a blog entitled When Franchising Meets Religion, Could Franchisees Be Left Holding the Bag?  Within the blog I discussed the fallout which ensued from the Chic-fil-A same-sex marriage controversy.  Chic-fil-A Chairman, President and CEO Dan Cathy made remarks regarding same-sex marriage which some people considered offensive, but which everyone knew would cause a stir in today’s political climate. 

Contemporaneously, there was a vast display of public patronage for Chic-fil-A by anti-gay marriage conservatives.  The interesting franchising issue within the controversy was the fact that Chic-fil-A franchisees who were located in conservative areas of the country received a boon in sales; meanwhile, many franchisees in liberal areas of the country were boycotted, picketed or suffered serious losses.  Unfortunately for the latter group, they had no pathway to protection against Dan Cathy and Chic-fil-A for the damages they suffered due to the franchisor’s public actions. 

If the moral turpitude clause is expanded as suggested herein, courts would have the ability to invoke the clause both ways similar to arbitration or attorney fee provisions, no matter if the clause is written to benefit only the franchisor.  Presumably, no court would find that Dan Cathy’s actions in the Chic-fil-A controversy exhibited moral turpitude, regardless of whether his comments were untimely and of poor business judgment from the standpoint of franchisees that were materially harmed.  But let’s replace Dan Cathy with Donald Sterling and keenly remember that the backbone of a franchise system is model uniformity and consistency at all of its locations, to the point where customers could not tell Sterling owned burger stores from local franchisee-owned burger stores. 

There would have been a far worse and longer lasting public backlash than was seen in Chic-fil-A.  There would not have been a similar wave of conservative support and financial reprieve from the ill effects of Sterling’s racial bigotry.  What rights would Sterling’s franchisees have had in that situation?  Same as Cathy’s, NONE.  What do you think Sterling would have done to rectify the effects of his behavior given that, unlike in the NBA context, he would have been virtually untouchable?  Not much.  Would he have allowed franchisees out of their franchise agreements?  Don’t hold your breath.  Currently, Donald Sterling even refuses to pay a standard NBA fine for the costly effects of his actions, let alone release racially offended players out of their contracts or sell his franchise.  Apparently, these concepts are laughable to him.

In today’s world of the 24-hour news cycle, TMZ, and expanding social media, franchisees are just as vulnerable to a Sterling Problem as are franchisors.  And given that franchisees have no other recourse, it is plain to see that if a Donald Sterling type franchisor continually and unapologetically damaged the brand with his acts of moral turpitude, franchisees who bought into his system and were being materially harmed by their association with the shared, infected brand would certainly want to argue for damages and contract termination under the expanded moral turpitude clause by stating, “Your Honor, what’s good for the goose is good for the gander!”

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